Not to be confused with pension transfers, pension recycling can be a straightforward way to move money between schemes and maximise your tax relief. And who doesn’t want extra bonus money for free?
The basic idea is that you take money out of one pension and use it to pay into another scheme. This may seem counterintuitive – after all, why would you take money out of your pension only to put it straight back in? Well, it can offer certain tax benefits like double tax relief, provided you stay within HMRC’s pension recycling rules.
Pension recycling is when you take money out of your pension and use it to make further contributions to another pension pot, benefiting from maximum pension tax relief.
Basically, you can recycle any sort of pension income, such as money you’ve withdrawn flexibly from a defined contribution pension (flexi-drawdown pension recycling).
However, pension recycling is mostly used to recycle some (or all) of your tax-free lump sun, which applies to the first 25% of a pension pot that you can withdraw from the age of 55 (rising to 57 in 2028) without paying income tax.
On the surface, recycling your pension is fairly straightforward. You simply take money out of one pension and pay it into another scheme, benefiting from the tax relief that is applied to pension contributions.
To benefit from tax relief on pension contributions, you’ll need to have some form of earnings or income other than pension income, such as employment income or certain benefits that would make you a taxpayer.
"By recycling money taken from your pension, it means you can receive tax relief on the funds twice. This is because you will already have received tax relief when you first paid the money into your pension. And by taking out money and putting it into another scheme, it’s possible to get another bump from tax relief.
Doing this means you can continue tax-efficient growth of your pot. And if you’re recycling money from your tax-free lump sum, you won’t have had to pay income tax on that money either. If you are recycling taxable income from your pension, any income tax you pay could be offset by this next round of tax relief.
When you get into the weeds of tax avoidance and loopholes, it can be worth getting professional advice to make sure you don’t break any rules. HMRC has some guardrails in place to try and stop people gaining an unfair advantage by abusing the system. But, efficiently managing your tax liabilities can be a useful part of retirement planning."
HMRC’s pension recycling rules apply to recycling your tax-free pension commencement lump sum (PCLS). There’s a different set of restrictions for flexi-drawdown pension recycling.
According to HMRC, the rules are designed to prevent people exploiting pension tax rules to generate artificially high amounts of tax relief.
You’ll fall foul of HMRC’s rules if all of the following apply:
Some of the points above are clear-cut (whether you took out a tax-free lump sum, and whether this exceeded £7,500, for example). But others are more open to interpretation – such as whether recycling was “pre-planned”.
HMRC has to prove that pre-planning took place, and HMRC acknowledges that it assesses each potential breach of recycling rules on a case-by-case basis. It has a few examples in its Pensions Tax Manual.
If HMRC finds that you have met all of the criteria in the rule checklist above, you will be deemed to have made an “unauthorised payment” into your pension.
If this is the case, HMRC can impose a charge of up to 70% of the value of your tax-free money.
You can, of course, try to avoid breaking the rules by keeping any additional pension contributions within the amounts outlined in the rules.
But, even if you exceed them, it doesn’t automatically mean you’ve broken the rules. The other factors come into play around intent, and whether your contributions are greater than they otherwise would be.
That said, it’s also possible to get caught out by accident. If you’re considering recycling some or all of a pension tax-free lump sum into another pension, it’s a good idea to seek regulated financial advice.
HMRC’s PCLS recycling rules only apply to money you recycle from a tax-free pension lump sum. They don’t apply to taking taxable, flexible income from a pension drawdown scheme and paying it into another scheme.
However, there are other restrictions in place that limit how much money you can recycle in this way, known as the Money Purchase Annual Allowance. This kicks in if someone with a defined contribution pension scheme either:
For most people paying into a pension there is an annual contribution allowance of £60,000 (or the level of their annual salary, if this is lower).
While you can contribute more than this per year, anything above the allowance won’t benefit from tax relief. The Money Purchase Annual Allowance reduces the limit to just £4,000, which restricts the amount of pension income you’d be able to recycle and benefit from tax relief.
Technically, there’s nothing stopping you from recycling types of pension income other than those we’ve covered above, such as monthly income from an annuity or a workplace pension. And accessing your money in these ways doesn’t trigger the Money Purchase Annual Allowance or any other restrictions on making further contributions. But, in practice, these schemes offer much less flexibility over how much you can take out (and re-contribute) compared with drawdown or UFPLS.
Pension recycling can be a useful way to maximise tax benefits and boost your pension pot. But it’s a legal grey area and it won’t be right, or possible, for everyone. And a misstep could risk a big financial penalty that far outweighs any tax benefits.
If you are tempted to try recycling part of your pension or tax-free lump sum, regardless of your reasons, make sure you’re aware of HMRC’s rules and restrictions. Consider getting some professional advice if you still don’t know where you stand.
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